Determining a customer’s lifetime value can reap big profits as you grow your business. However, if you are like just about all small business owners, you most likely have never determined the lifetime value of your customers and are thus forfeiting maximum income potential.
Do you understand what your customer’s lifetime value is?
Do you acknowledge why knowledge of your customer’s lifetime value is important? If you don’t understand the answers to these two questions, read on.
Too many businesses view their customers as simply a single purchase or perhaps a single purchase plus one additional backend purchase rather than understanding the lifetime value of their customers.
“Lifetime value is expressed as the total dollar value of your average customer over the entire period that they’re likely to do business with you.” – Bob Serling
So, how do you derive the lifetime value of a customer?
Finding the lifetime value of your customers takes for granted that you have multiple items to offer to your customers. Backend sale items may be your own or some affiliate product, but you must have a number of follow-on things (products to market after the first sale) to sell so that your customers have a number of chances to buy from you.
If you have been in business for a while, first find out the average length of time a customer stays with you. Next take net profit you have earned over this period of time and divide it by the number of steady customers you have.
For example, let’s assume you have been in business for six years. You view your customer list and find out that on average, your customers continue three active years with you before dropping into inactive status. During the past three years your total net profit has been $480,000 and your customer list numbers 1750 active customers.
To derive the lifetime value of each customer, you apply the following formula: Lifetime Value = Net Profit / steady customers or in the case above, it would be Lifetime Value = $480,000/1750 or $274.28
So why is this significant. Because, now you know that each new customer you acquire is worth $274.28 dollars to you over the average customer life of 3 years. Now you can estimate how much you can spend to get a new customer and continue to get a profit.
Now, let’s see some examples of how we can use this information.
For the purpose of this example let’s consider that you have an internet business with a website designed for selling your products. Let’s further consider that you are operating a Pay-Per-Click marketing campaign. You have calculated that one out of every hundred visitors to your site converts into an actual paying customer. You have a keyword that you are bidding 50 cents on. Which means that for every 100 customers you get through that particular ad you will convert one into a customer so to acquire that customer cost you $50.
[Note: If you are operating an offline business, the same principles can be applied to direct response advertising by replacing pay-per-click with a written advertisement that permits you to track your responses from that ad.]
Now let’s say that the product you are selling at this website sells for $39.00. Many website owners would assume that the Pay-Per-Click campaign with this keyword was a failure, because, you just spent $50 to benefit a new customer who bought a $39 dollar item. This is an initial loss of $11 for every new customer you gain by this campaign. However, taking the longer view, that $50 dollars actually earns you on average $274.28 for each new customer over a period of three years for a profit of $224.28!
Now, instead of being a failure, your Pay-Per-Click campaign can be regarded as a great success. Spend $50 and get $224.28 back. How often would you like to do that?
Selling to your existing customers is always easier than getting new customers. You already have earned their trust, they have already bought from you and if the product or service they purchased from you was of high quality and met all their expectations or if you over delivered, they will most likely buy from you again. Satisfied customers are repeat customers.
So, if you want to maximize your profits, figure out the lifetime value of your customers and design customer acquisition campaigns that will skyrocket your total net profits rather than campaigns that consider only an initial sale.
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